It's a Trap!

There were only a few times in a long time of history where volatility has been comparable to the action over the last several weeks and months. I've heard of '98 being quite volatile and 2000 but I personally didn't trade then (well, I paper traded 199-2000).
One of the important mechanisms of the market is the "short squeeze" nd the "margin call" that causes very violent directional moves particularly when the large majority of capital is stuck on one side of the market with little action to support the otherside. Although amateurs might think having everyone bullish is good for the market it is the opposite as a certain inflection point occurs. At some point the inability for anyone else to come in and support the "bid" (because everyone is long and leveraged up as much as they can or are willing) means that the SMALLEST amount of selling pressure now means there is no one to buy lower prices left. stocks must continue downward until they find a  "bid" and that creates margin calls.
Margin calls are when people owe more money then they have and must sell shares of existing stock in order to either satisfy the margin requirements or get off of margin completely. If they don't volentarily sell enough by the end of the day the selling is then forced and the brokerage reserves the right to liquidate. When everyone is trapped long this can happen very quickly.
Often times there is substantial hedging that also may occur as markets begin declining from people who want to protect portfolio from further margin calls as institutions with hundreds of millions or billions or more under management cannot liquidate so quickly. At some point the selling pressure doesn't continue and at some point there are people that are the old men investors like Buffet that are patient that will step in and create a bid, and at some point the forced selling gets everyone off margin.

It is actually often short sellers that COVER their shorts and buy back their shares that often times helps to find a bottom along with value investors. That creates the second mechanism...
The short squeeze!
The short squeeze is the same concept but on the opposite side. those who sell short or that sell option without a hedge at some point are forced to "cover" or buy to prevent a margin call. The short squeeze occurs when there are many sellers that are short that now have to cover. Their buying and other buying triggers more short sellers that are above a particular price point in which they now must cover or risk the forced covering (or selling if they have hedges or long positions). This creates pressure points in the market that create FAST movement.
If you can learn to recognize WHEN and WHERE the players will get trapped over capitalized and unhedged, or undercapitalized and overhedged you can identify points in which market speed can pull a lot of people out and the market can run away in a trend in either direction.
Although every buyer technically has an opposite seller,, you still have points when those interesting in buying no longer can fund purchases, and points where those interesting in selling have either exhausted their shares or have gone short as much as their broker will allow(or as much as they are willing). You can recognize classic psychology of buyers and sellers and look at price and volume history for clues. The other thing that has a lot to do with future direction is market speed AND length of time trading at certain levels. The more speed and the longer the period of time traded at certain levels the more likely that the resolution will be of greater consequence. The breakout or breakdown at that point results in a huge number of people caught wrong and strong conviction on both sides now having to have one side admit defeat. Meanwhile, their conviction sometimes creates plenty of people reluctant to admit defeat. The more people that short a rally, the more fuel for short squeezes you will continue to have if the buyers remain in control. As I started this article saying, there are few times when the market has been as volatile as it has been. 2008,2009,flash crash,and the 2011 credit downgrade and then the recent action. In each case you had a huge shakeout. In 2008 on the way down there was some massive short covering counter trend moves that caught people on the wrong side. Initially the shorts covered and would then short again but many people got trapped trying to buy the dip and thinking the bottom was here trying to buy the rally. They had to liquidate on a market call once their stops got taken out. the flash crash a ton of stops got taken out and forced people out and then eventually the market was bought aggressively. 2011 flushed well beyond oversold and forced a lot of people to capitulate. I believe the major capitulation here is in energy and a bottom will form but I am not certain market will lead. This fast rip higher may be where many longs get caught. Or it may be all the shorts that got caught below that has provided additional fuel to keep this rally going. Unfortunately there is a high degree of uncertainty at any given point in time in the market, particularly with regards to WHICH direction. However, the one thing you can do is manage your risk which gives you an advantage over some of the big institutions that can't simply press a button and liquidate their entire position at the market as the market cannot absorb all of the shares and as they begin to sell prices will go lower and as they sell more prices will go lower and by the time they are out they would have sold potentially several percentage points below where the market price was when they hit the market order. At this location we very well could V reversal from the low and just keep on going. If/when we take out the prior high the market can gain additional momentum. I actually like hedging into strength here. As an options player, you can bet directionally and if you get a large move you can gain several times your investment and if you are wrong you only lose your initial investment. As traders you always want the reward to outweigh the risk. However, with options it is a lower probability system and you need to be right often enough for your large win to pay for your losses and then some. The risk and ultimately reward relative to your risk is highly rated to the cost of volatility. When volatility is high you need a larger move to generate the same return. For this reason option buying becomes more problematic. The volatility index is currently a bit rich but not excessively so. Betting on both directions on one particular stock via a straddle or a stangle however would be too costly as you would have to outweight the volatility cots on both sides. However, if you can manage risks and pick individual setups you may find that there are good setups on each side. One individual stock may setup such that if you are right you gain 3 or 4 times your risk due to a large upside move. Another stock may have its large risk to the downside. At this point in the market it is vital that you continue to pay attention to the speed and direction of the market and volatility but you look for asymmetrical opportunities of returns. If you trade stocks you might have a stop with a margin of error to account for volatility and have your upside represent gains in excess of your risk by several times. Currently I believe the market's best setup to anticipate at THIS particular location is a topping pattern because if you are wrong you can try to cut your losses, recoup some of your option premium, and it won't be too hard to flip. However, correlations ahve declined and individual stocks are setting up again to the long side so if we do break through you can still identify opportunity. Nevertheless with volatility more expensive, I would still suggest paying attention to the VIX and for now really limit your position size to maybe half that of normal conditions . It is very possible volatility will contract for awhile before the market decides on a move and that could mean losses on both sides or either side you play. Either have an edge on an individual stock and pick a side,or keep it small and continue to play allocation strategies while also considering a market directional hedge here. With the clear path forward signalling potential for major market direction resolving in the future I think SELECTIVELY option buying is still okay, although more difficult than usual and I would not consider trying options out here if I was not experienced in them at this time) Sometimes only time will tell what direction, and to some it may seem like a cop out to find a complicated way of saying "market will go up or down unless it trades sideways", but you can also handicap MAGNITUDE and speed and determine a spot where the upside if you are right about direction outweighs the downside, and how to act if it starts to play out a certain way. Similar to an allocation strategy, the idea behind a good trading strategy should be to make money over hundreds or thousands of trades without having to predict market or even stock direction with greater than 50% accuracy. Most of the time I don't care about what the market does, because unless there is a fast, correlated decline, I can still find which stocks that the market is rotating into and they should do well even in declines, or at least my losses should be small relative to the gains that I do capture so that over time I need not predict the market. However, market SPEED and volatility are very important as it indicates the risk of a correlated selloff AND indicates the cost of options and ability for option strategy to generate large enough returns to make the strategy worth pursuing.